CROWDFUNDING - INTRODUCTION

Crowdfunding is solicitation of funds (small amount) by entrepreneurs or

business from multiple investors through a web-based platform or social
networking site for a specific project, business venture or social cause.
Area of Focus: Indian Startups and SME’S
• Started in 1997, Marillion, british rock group, raised U.S $60,000 in
donations by fan-based internet campaign
• Father of crowdfunding, Brian Camelio, started CFP’s for artists and raised
funds for 10 Grammy winning music awards.

INDIAN SCENARIO
In 2012, a successful year, Wishberry followed by Kitto and Milap and in
2015, Impact guru, largest platform for medical causes were launched for
fundraising.
• In 2013, first ever crowdfunding regional film, Lucia raised Rs. 51 Lakh in
just 10 days through Facebook page and a blog.
• Dhirubhai Ambani’s small yet growing textile business was crowdfunded
by communities across Gujrat.
CROWDFUNDING MODEL

HOW DOES IT WORK?

• PITCH- idea or project with fundraising targets or milestone.

• Screening- the “platform” (website used) will screen the pitch before it
goes live.
• Pitch Goes Live- gets a webpage that includes project details, targets,
fundraising deadlines, any rewards, amount raised so far etc.
• Money Pledged by Public- Funding is received according to the model
opted for i.e. either “All or Nothing” / “Keep It All”.
• Project Development- Distribution of rewards promised to offer the
public.
 TYPES OF CROWDFUNDING

General statutes such as the Income Tax Act, 1961, The Foreign Contribution (Regulation) Act, 2010
(FCRA) and the Foreign Exchange Management Act, 1999 (FEMA) applies to all types of
crowdfunding.
 COMMUNITY CROWDFUNDING
DONATION BASED CROWDFUNDING
• Solicitation of funds for social, artistic,
philanthropic or other purpose, and not in
exchange for anything of tangible value.
• Area of focus: Social causes.
• No yield or returns on investment
• No minimum or maximum amount for donation.
• Service Fees : 5 -10%
• Example: Milaap, Rocket fund, Impact Guru,
Crowd funder, etc.
REWARD BASED CROWDFUNDING
• Solicitation of funds from investors in exchange for
existing or future tangible rewards
• Subset of Donation Crowdfunding.
• Three Categories:
Pre orders, Services and Recognition.
• Area of Focus: Small Entrepreneurs, Free software
development companies, creative & innovative
projects.
• Examples: Wishberry,
• Indiegogo and Kickstarter (largest)- run at least
4,00,000 projects including “Potato Salad and
Mission to Mars”.
• Fundly- 4.9% service fees
 FINANCIAL RETURN CROWDFUNDING
PEER TO PEER LENDING / DEBT BASED
• Also known as “Direct Consumer Lending” /
“Market Place Lending”
• An online platform matches lenders/investors with
borrowers/issuers in order to provide unsecured loans
and the interest rate is set by the platform.
• Regulated by RBI under NBFC-P2P licence.
• Amount of borrowings vary.
Ex: OML- request loans between Rs.25,000-10 Lakh
• To meet short-term requirements.
• Examples: Lending club in U.S, Zopa in U.K,
i2i Funding, LenDenclub etc in India.
EQUITY BASED CROWDFUNDING
• It refers to fund raising by a business,
particularly early-stage funding, through offering
equity interests in the business to investors
online.
• SEBI has called out laws on digital equity
crowdfunding as unauthorized, illegal and
unregulated.
• Area of focus : Small entrepreneurs, early stage
companies.
• Mostly prevalent in U.S and U.K
• For example: Syndicate Room , Crowd cube,
gust, Fundable etc.
 WHY IS CROWDFUNDING PREFERRED?

 Alternate source of funding and allows increased flow of credit to start-ups, SME sectors, and other users.

 Validation of Concept – An excellent opportunity to present the business / project to masses.

 Assists SMEs to raise funds at a lower cost and through a simpler procedure as compared to other modes.

 Efficiency- The platforms ability to centralize and streamline the fundraising effort will result in ample time for the borrower
to run the business.

 PR &Marketing- Promotion and campaign opportunities through social media and other marketing tactics.

 Presentation- Creation of crowdfunding campaign helps in reviewing the business and polish it better.

 Due Diligence and vetting of the projects hosted on the platform’s website to maintain their reputation.

 Networking- Enables borrowers to reach to wide range of investors that are beyond personal connections.

 Encouragement in growth of SME’s and boost in country’s economy.

 RISKS INVOLVED IN CROWDFUNDING
 Risk of Default: Inadequate recourse available in case of temporary or permanent shut down due to
overdue maintenance or hacking. Ex: Quackle.

 Risk of Fraud: Possibility of genuine website being used by fraudsters and false websites being established
leading to risk of cyber security and identity theft.

 Risk of Failure: High failure risk as funds raised by early stage companies or ventures depend on future
possibilities . Ex: Bubble and Balm, a fair trade soap company.

 Information Asymmetry: Certain investors may have access to information which is not available to others.
Accounts raised and deposited by platforms not monitored
No stringent obligations on reporting and transparency leading to misrepresentations.

 Systemic Risk: Secondary market not available for investors causing a risk of low liquidity.
Can give rise to cross- border implications.
 CONSULTATION PAPER ON CROWDFUNDING - SEBI
1) Access to Market and Eligibility of Fundraisers.
• Size of issue not exceed Rs. 10 Crores.
• Not promoted, sponsored or related to an industrial
group with turnover more than Rs. 25 Crores or having
an established business.
• Listed and less than 48 months old.
• Not engaged to real estate or policies prohibited under
India’s Industrial Policy .
• Directors, Promoters and Associates not declared as
“defaulter” by RBI / CIBIL and not prohibited from
accessing capital market.
2) Accreditation of Investors and Investment
Limits.
• Participation Restricted to Accredited investors.
QIB’s – 5% of each company.
Companies with minimum net worth 20
Crores. HNI’s with minimum net worth 2 Crores.
• Eligible Retail investors – Do not invest more than
Rs. 60,000 and 10% of net worth.
Min annual gross income 10 lakh.
Filed income tax return for min 3 preceding financial years.
Well advised and passed an appropriateness test.
 3) Regulation of Portals

Platform categorized into 3 kinds.

i. Class I Entities- Recognized Stock Exchanges with nationwide terminal presence (RSEs) and SEBI
registered Depositories.
ii. Class II Entities - Technology Business Incubators (TBIs); registered as society or non-profit company -
at least 5 years old and minimum net worth of INR 100 million.
iii. Class III Entities- Associations and Networks of PE or Angel Investors, registered as a non-profit
corporation;
Minimum: paid up share capital = INR 20 million, Track record = 3 years, Strength= 100 active members.

4) Procedure and Disclosure Requirements

Procedure requires the company’s details be displayed on website and circulate a private placement offer letter to the
interested investors.
Companies are required to circulate information similar to private placement under Companies Act, 2013.
These disclosures include:
Name of the company, registered office address, history of funding, financial condition of company, ownership
details and capital structure, etc.
 LOOPHOLES OF CONSULTATION PAPER

• Restricted to accredited and retail investors:

• Unwillingness of accredited and retail investors to use crowdfunding platforms.
• Effects donation based and reward based.
• Removal of “crowd” from crowdfunding.

• A cumbersome process imposed on the issuing company.

• No Fee Structure: It is crucial for targeted entities to analyse the capital raising cost.

• No Secondary Market for Equity Crowdfunding:

• Through Buy-back of securities under CompanieAct,2013.
• To another accredited investor.
• To a family member or relative or friend of the existing investor.

• Classification of Entities: Prevents business from developing and curb donation or reward based platforms to run equity
based crowd funding campaigns.

• Increased cost and Reduces Efficacy: Proposed procedural requirements, due diligence and background and regulatory
check for the investors holding above 20% equity .

• Skipped the issue of Cross- Border Crowdfunding.

 EQUITY CROWDFUNDING: A PRIVATE PLACEMENT OR
PUBLIC OFFER ?

ANALYSIS: SAHARA CASE

(Sahara India Real Estate Corporation Ltd. & Ors. v. Securities Exchange Board of India & Anr )

FACTS:
Two unlisted companies, SIRCL and SHICL, raised funds over USD 3 billion from nearly 30 million investors by
issuing OFCD’s and distributing information memorandum through approximately a million agents and three thousand
branch offices to more than specifically to and/or friends, associated group companies, workers/employees and other
individuals associated with Sahara Group were eligible to apply for the issue of these OFCDs.
ISSUE:
Whether the OFCDs issued by SIRECL and SHICL were by way of “private placement”- as claimed by the Sahara
Companies on appeal, or by way of an invitation “to the public” - as counter claimed by the SEBI?
JUDGEMENT:
The Court accepted SEBI’s contention that the OFCDs issued by SIRECL and SHICL was by way of an invitation “to the
public” and therefore sufficient in order to attract the provisions of Section 73. (Mandatory listing of securities)
AFTERMATH:

Ministry of Corporate Affairs introduced a new provision in the then Companies Bill 2011 (enacted in 2013).
The Companies Bill 2011 was scheduled to replace the earlier Companies Act of 1956 and inserted Section
42(2) , explanation 1.
Section 42 (1) & (2): private placement be offered through private placement offer letter.
Limits investors who can issue shares up to 50 members and who can make offer for issue of shares up to 200
members in a financial year, excluding QIB’s and employees.

Section 42(2), Explanation I –

If a company, listed or unlisted, makes an offer to allot or invites subscription, or allots, or
enters into an agreement to allot, securities to more than the prescribed number of persons,
whether the payment for the securities has been received or not or whether the company
intends to list its securities or not on any recognized stock exchange in or outside India, the
same shall be deemed to be an offer to the public and shall accordingly be governed by the
provisions of Part I of this Chapter.
 SEBI’s APPROACH

Investor Caution Notice (2016)- On 30thOctober, 2016, press release issued , SEBI found that:-
“The electronic platforms are allegedly facilitating investment in the form of private placement with
companies, as the offer is open to all the investors registered with the platform amounting to a
contravention of the provisions of Securities Contract (Regulation) Act, 1956 (SCRA) and the Companies
Act, 2013.” 
Questions raised on legality of platforms like, Lets Venture, Term Sheet, Equity Crest, Grex, etc.
Listed over six digital equity crowdfunding platform “unauthorized, unregulated and illegal”

• Notice and Disclaimer (2017): SEBI sent notices to a dozen angel networks asking them to reveal
details of their fundraising business.

Disclaimer – “crowdfunding platforms are neither stock exchanges nor authorized by the capital markets
regulator to solicit investments and declare the securities traded on these platforms are not traded on any
regulated exchange.”
 JURISDICTION – SEBI OR MCA?

• SEBI doesn’t have absolute jurisdiction and overlaps with MCA as it is a hybrid of both public offer and
private placement.
• Crowdfunding participation not limited to listed public companies but extends to unlisted public and private
companies.
• Private placement not prohibited under companies act, 2013 and recognizes maintenance of statutory register
in electronic forms.

• MCA Jurisdiction – Private placement regulated under Section 24 of Companies Act, 2013.
• SEBI Jurisdiction (Sahara Case )- Section 55 A of Companies Act, 2013.